Investing and Financial Doomsday – Page 9

This Is Some Rescue

“This is some rescue. When you came in here didn’t you have a plan for getting out?”
– Princess Leia, Star Wars (1978)

And what a rescue it is. What started as a three-page plan to buy troubled assets has grown to a 451 page mess that includes everything from Indian Employment Credits to adding a Seven-Year Cost Recovery Period for Motorsports Racing Track Facility. I guess in the future we know how to get recalcitrant Republican Congressman to reverse course- include more pork. We should all remember for future reference that the government rides to our rescue by way of hurriedly passing a bill no one had a chance to read that includes more spending of money they don’t have.

I’m not sure if this was the kind of rescue that the American people were counting on, but given how they were reacting to this plan (about 90 to 1 against judging from people calling in), it was probably the one that they were expecting. And the thing that no one seems to want to being up is that the government caused this problem to begin with. If not for the government created entities of Fannie Mae and Freddie Mac, we would not have had so extreme a credit explosion in the housing market. If not for the government created entity of the Federal Reserve and it’s nasty habit of keeping interest rates low and solving every problem by throwing more fiat paper at it we would not have had this orgy of credit and speculation to begin with.

Each of these entities was created by the government to rescue the free market:

– the Federal Reserve was created by the government in response to the Panic of 1907 and the desire to have a “lender of last resort” with an “elastic currency” that could bailout any troubled bank.

– Fannie Mae was created by the Roosevelt Administration in an effort to provide credit to the housing market to stimulate the economy. Except that now that had created a government sponsored monopoly of sorts. So in order to fix the situation, they created yet another entity, Freddie Mac, in 1970.

And here we are, now having to create more programs in order to save our would-be rescuers. Can there be any doubt of the wisdom of Ludwig von Mises in his Critique of Interventionism where he argues that all government interference in the operations of the free market will merely lead to bigger problems later, which the government must then solve with even more interference. According to Mises, all attempts at intervention lead to the same place, Socialism. And here we are. Watching the Republicans, the champions of the “free market”, back the biggest interventionist step ever proposed.

Life is full of ironies, but not greater than the ironies of the public sphere. Some hypocrisies are to be expected. After all, this is politics. But I’m sure that the Japanese, who were advised by the Americans to just let the chips fall where they may when their crisis hit, are noticing that we don’t take out own advice very well. But for me it goes beyond irony and hypocrisy that the Republicans continually berate the Democrat’s for being Socialist as they aggressively expand the size and scope of the federal government. To me it proves that the American people have lost the political will to force their politicians to own up to their promises. Thus we are left with people’s perceptions of their government and its actions determined not by the actions themselves but rather what the politicians tell the people their actions mean. According to the Republicans, bailing out a failure caused by three government created entities is merely what must be done to save the “free market” from itself.

I started this piece with a quote from Star Wars. As a science fiction person I would like to close it with a quote from another piece of SciFi, George Orwell’s 1984. Orwell, like Mises, foresaw the government’s continual encroachment into our lives, just as he foresaw that the government would shape people’s perceptions by telling them that something was it’s opposite. And so I want you to keep in mind our “free market” Republicans, their “War on Terror”, and their often trumpeted habit of being fiscally responsible when you hear that:

WAR IS PEACE
FREEDOM IS SLAVERY
IGNORANCE IS STRENGTH

Is It Feasible to Return to a Gold Standard?

I’ve gotten a couple of questions from a couple of different readers regarding how feasible it would be to return to a gold standard. The argument goes something like, “If our national debt $9.6 Trillion dollars, and gold is $900 an ounce, how on Earth could we return to a gold standard since we don’t have nearly enough gold ounces.”

This question confuses the current market value of gold with what a gold standard is. A gold standard is merely a commitment that a currency is now redeemable at a set quantity of gold and does not have to in any way mirror the current market value of gold. The US government could return to a gold standard today if they wanted to by committing to redeem all US dollars into gold at the ratio of $1,000,000 per ounce. Under this standard, the US would now need $9.6 Million ounces or roughly 300 tons, which is easily done. Now a lot of you might be thinking, “But that’s way too high a value of gold,” but you’re again confusing the current market value of gold with a government’s commitment to support it. Setting a high value like $1M an ounce means the government has set a very low bar for itself in terms of gold redeem-ability; somewhat like an out of shape person deciding they can only manage five sit-ups a day to begin.

Once the exchange rate would be set, the marketplace would adjust to reflect this new reality and probably soon reflect the new exchange rate. That means that, from that point forward, gold really would be $1M an ounce! “But that’s preposterous!” you want to blurt out, but be patient. You see, the entire exchange rate of goods and service would soon reflect this new information, and we’d pretty quickly start to see other prices rising to meet gold’s new price. That would mean you’d probably see oil selling for $100,000 a barrel, and the average rate of labor becoming somewhere around $10,000 an hour. Yes, the adjustment period would no doubt be a bit hairy, but once it was all done, the US would be on a gold standard once again. (Incidentally, if you’d like a more elaborate and gradual plan to implement the gold standard, I’d recommend you check out G. Edward Griffin’s The Creature from Jekyll Island.)

Now once this gold standard was in place and the market place had had time to adjust to the new reality, the government would have to start making some harder choices. If it wanted to implement a new entitlement program or conduct another war, it would have to ask itself “Where are we going to get the gold to do this?” And if it couldn’t? Well, no gold means no program. No war.

You see, the reason for the confusion at the beginning is that the government has just been conducting whatever programs and wars it wanted to over the last few decades. They have had to face the same question of “Where are we going to get the money to pay for all of this?” but they have been able to answer with, “We’ll just print it.” That’s why the gold standard was eventually abandoned and why our liabilities are so far in excess of our ability to pay that the mere thought of entertaining a gold standard causes the mind to boggle at the discrepancies.

That gold is trading at such a low level in comparison to this nation’s liabilities is no accident. The US Treasury and the Federal Reserve have been working very closely to have the US Dollar maintain its value despite the fact that it continues to be printed at will. In essence, this exercise has allowed us to peek behind the curtain and see that the “Great and Powerful Dollar” is really a construct that is carefully maintained by a few people in the know. This is also why I’ve chosen to entitle my book, “What Do You Mean My Money’s Worthless?” There is simply no way this nation can afford to repay its liabilities and the value of the dollar is going to be the ultimate casualty.

Answering Nat’s Questions

Nat, good friend and now a blog reader, asks two questions:

BTW, Preston, I am about halfway through you book. It’s a good read, especially considering the recent economic catastrophe. I am curious why you think gold should be the standard of monetary policy as opposed to some other commodity. Though problem: If gold were still the standard and in the future we discovered gold on another planet…how would that affect the economy? Supply and demand would dictate that gold would immediately see a reduction in value because of increased supply. I am curious as to your opinion on owning land.

I just read an article that suggested that due to the U.S. making a deal with OPEC to only accept the dollar back in the day that technically, the U.S. dollar is backed by oil…i.e. the OIL STANDARD. What’s your take on that theory?

Let’s take gold first. A lot of what I’m going to say was already well argued by Dr. Murray Rothbard in What Has Government Done to Our Money. As Rothbard argues, the advantages regarding gold is that it has intrinsic value. To argue otherwise is to go against at least 4000 years of human history. Human’s like gold. Always have, always will. Now they also value a lot of other things (real estate, diamonds, art, oil) but the advantages of using gold as money is that it is reasonably easy to transport (unlike real estate), is a dense way to store wealth (unlike oil), can be stored for long periods of time without loss, and can be broken down into fundamental units of accounting to make exchange easy (unlike diamonds). There are few other forms of wealth that meet all of these requirements.

Now how much people value gold changes over time. Some estimate put the “gold to dollar” exchange ration at about $3000 in the Middle Ages. The entire European What happened next should help to answer Nat’s next question about what if we suddenly found a source of gold that would drop gold’s value relative to everything else, because that’s exactly what happened. The New World was discovered and with it the vast golden wealth of the Incas and Aztecs. The value of gold suddenly dropped to roughly $800 or so. This caused inflation as the cost of goods and services went up in comparison to gold because of this sudden increase in supply, but after this happened the economy went right on about it’s business. There was no calamity.

Now in regards to your other question, yes I do feel that the US government has made deal with Middle Eastern governments. In fact, John Perkins discusses exactly how the United States got third world governments to play along with our economic wishes in his two books, Confessions of an Economic Hitman and his followup book The Secret History of the American Empire. Perkins books are fascinating because they are basically an inside account of how the American empire was build coming from someone who was involved from the inside. I believe that the CIA engineered the Shah’s rise to power. Similarly, it is common knowledge that we the US government has long been an ally of the Saudi Royal family. That is why the so many of the 9/11 hijackers were Saudis: the Saudi citizens hate the ruling family but feel that they can not get rid of them unless the United States allows it.

Why It’s Worse Than You Think

Recently reader Bob Kraus wrote another comment to my blog which you can read here.

In essence, Bob is arguing that our policies regarding monetary inflation are to our benefit because we are trading the worthless commodity of paper for the very worthwhile commodity of (among other things) oil. Bob acknowledges that he we have “hosed” the rest of the world by perpetrating this sham but, as he puts it, “what else is new?” Bob also acknowledges that the American economy going forward “is going to be a very painful 3 or 4 years for most Americans.” Despite these acknowledgements, Bob remains a stalwart bull for the US economy because he feels that no other country is as innovative or works as hard as the United States. He feels certain that it will be the United States that innovates the next technology that will replace oil and that our manufacturing will return because the dollar has fallen so essentially the American consumer can not afford to buy imports anymore.

Bob’s thoughts are not uncommon, so I wanted to address them here. Here’s the problem with Bob’s analysis. Currently the US government’s official debt is roughly $9.6 Trillion, but that doesn’t include the liabilities the government just took on with Fannie Mae and Freddie Mac (roughly another $5 Trillion) or the “unfunded” portions of Medicare (roughly $85.6 Trillion). If the US is to make good on its debt then the US is going to have to start seeing savings both on the government level as well as the consumer level, which would be a massive credit contraction over the next couple of decades. Basically we’d be seeing the opposite of what’s been happening over the last two decades where the US has gone deeper into debt. Now given that bull market projections for US stocks earning more going forward are assuming a continuation of the last twenty years, we’d be seeing a much lower level of earnings as the US consumer and government had to drastically rein in their spending. Furthermore, the holder’s of our foreign debt would actually have turn out to not be “hosed” because the dollars the debt would be paid for in a deflationary scenario would actually be worth more than they worth during the inflationary times. That’s assuming that the US actually choses to make good on its debt.

Now what if it doesn’t? What if instead the US choses the easier path of just defaulting on its debt. Well in that case, I don’t see how gold would not be a far superior investment than the stock market. It’s tough to predict what would really happen were the US Dollar to be rendered worthless, but you could expect a great deal of societal chaos and upheaval as well as a flight of foreign capital from our shores. None of these things are particularly bullish for stocks.

Regarding Bob’s longer term view of the US as being the best at innovation or working harder that most other nations, well I’d certainly like to hope so. I’m not nearly as confident as Bob is that the US is going to continue to be the source of all things economically good, but even if this is true, the fundamentals of the United States level of indebtedness are simply against any kind of scenario where stocks become strong investments over the next decade or so.

The Republicans Find Religion

A lot of my friends get all bent out of shape when it comes time to elect the President. They act as though it were a matter of life or death to make sure that the next President is the one they happen to be supporting. And, of course, they are correct. The President will have to make many life or death decisions. Still, I can’t seem to get all worked up about who gets elected. In part that’s because I’m a Libertarian. Being a Libertarian means that regardless of who designs the ballots in Florida, or whether we have gone from punch card to electronic voting, my candidate is not going to win. Ever.

In many ways that’s a relief. I have made peace with the notion that I will never be on the winning side of a Presidential election, and so I experience neither joys nor sorrows come election night. More typically I just get a few chuckles. For the vast majority of voting Americans, however, elections do not seem to bring any peace. Politicians have been studying how to get elected so long that it would seem that they have discovered that the voters seldom if ever hold them accountable to the political promises they made when they were last running for election. And so politics operates like a strange kind of job where you have to continually reapply for the same job you already hold, but no one actually pays much attention to what you say during the interview; if you just promise to be a star performer you’ll keep getting the job because no one really seems to care whether you ever even show up once you have actually gotten the job.

I am reminded of the old Peanuts gag where Lucy holds the ball out for Charlie and pulls it away when he goes to kick it. Lucy has done this to Charlie countless times, but still somehow manages to convince Charlie that this time she really means it. But she always pulls the ball away and then ridicules Charlie with “You Blockhead.”

That’s how I see the US political system. Every two to six years, the major political parties hold out footballs for the American people to try to kick. The American public has been here before. It knows that every time it goes to kick the ball and elect someone, that the person they elect will unfailingly pull the ball away and not live up to the promises made. I think it’d be a refreshing change if political victory speeches were reduced to the victorious candidate coming before the public and saying, “You Blockhead.”

That’s what makes this current crisis so interesting. There is actually a very short span of time between the actions taken now and the next election, which puts politicians in the very unusual situation of having their recent performance considered by people going to the polls. And this is perhaps why the House Republicans recently took the very unusual action of defying their Republican President’s wishes and voting down his bill. Republicans have traditionally kept a very disciplined core of elected officials. You never see a high profile Republican going to speak at the Democratic National Convention, for instance. And, yet, they may as well have as they gave not only George Bush but John McCain his walking papers and voted down the bill they both vocally supported. Even weirder, Bill O’Reilly recently attacked right-wing “Kool-Aid drinking idiots” in calling for this bailout and attempting to blame Clinton when, according to O’Reilly, it was clearly “Bush’s fault.”

Sacre Bleu! What in the world has gotten into them? Are these the same people who reauthorized the Patriot Act to keep us all safe from terrorism? Or told us how necessary it was that the President conduct illegal wire-tapping surveillance? I mean how is it possible that the Republicans gave Bush Carte Blanche to carry out whatever policies he asks for but suddenly shoot him down on a bailout of Wall Street?

If I didn’t know better, I’d say they suddenly “found religion” and started comparing their actions against the rhetoric. Suddenly the free market, an intangible entity that doesn’t vote and no one really seems to want anyway went from stale talking point to more important than party loyalty. How on Earth did that happen?Well, I hope the Republicans stop messing with my head, because I’m not used to them actually honoring their free market rhetoric. When there is an unflinching faith in the power of people to decide value in the marketplace, can you then long ignore that the marketplace can’t really function well without an honest money such as gold to go along with it? Am I to hear House Republicans tomorrow call for the abolishment of the Federal Reserve? If they keep it up I’d have to start actually questioning whether I should become a Republican myself!

But then, lest I forget, this is simply politics right before an election. I suspect the Republicans’ sudden “come to Jesus” moment may have more to do with the November elections than with a sudden discovered passion for free market forces. Time will tell, I suppose, but I’m not one to say that that many leopards can change their spots that darn quickly. Still, it was good while it lasted.

In Defense of Permabears

A recent comment on my blog was submitted by Bob Kraus who writes:

“For the most part, the US economy has grown and grown and grown throughout its history with mostly only hiccups representing the breaks in growth. It seems that for every year of growth, you might only have a month of contraction. The problem is that most bears who’ve had any reasoning behind predicting that the US banking system would fail were permabears. While permabulls are right 90% of the time, permabears are wrong 90% of the time. Why are they willing to be wrong so much? It seems obvious to me – permabears WANT the US economy to fail (perhaps they are mostly communists, who knows). As a result, no one EVER listens to them. It was kind of like when the National Enquirer claimed that John Edwards was having an affair. No one listened because they have a history of sensationalizing everything. Bears are no different.”

Before I respond to Bob, I wanted to define some terms so that all readers could follow what we’re talking about. A bull is someone who feels optimistic about a particular form of investment. I am bullish on investing in gold, for instance, because I feel gold is going to go up. The converse of being a bull is being a bear. I am bearish on the US stock market and US Dollar. Sentiments can change from time to time as the value of various investments change in comparison to each other. The term permabull is someone, such as Ben Stein, who always seems to be bullish on the stock market regardless of current events or what PE ratio the stock market is trading at, just as a permabear is always down on the stock market.

Thus Bob is saying that the only people who predicted this downturn where people who were permanently pessimistic regarding the American economy. He speculates as to our motives, that we want the US economy to fail because we are Communists at heart and just hate the operation of the free market. In summation, Bob argues that permabears are to be ignored because they are wrong 90% of the time and the US economy will soon be back to expanding year after year.

Bob is wrong. Individuals such as Warren Buffett were saying that the US stock market was a bad deal a decade or so ago, and he is hardly a permabear or a Communist. Speaking entirely for myself, I am a permabear because I feel the American economy is doomed to fail. I have not adopted this view because I am a Communist, but because the modern economy simply doesn’t make sense to me. The way I look at it, Economics is about the exchange of goods and services. In order for a society to proper, it must allocate its resources and labor towards the efficient production of goods and services that people want. If a society succeeds in producing goods that another society wants, then they may engage in trade. But trade between societies must be a zero sum activity: one society can not consistently run a “trade deficit” to another society whereby it gives less in the trade value of goods and services than it consumes. How can a society continue to convince another to deliver less in value that it is itself offering except to make up the difference at some future date? Real goods and services are all that matter. I do not measure wealth in terms of dollars, but instead in terms or how many its “real” (commodity based) value. Similarly savings is properly measured in terms of unconsumed economic goods; I say goods because one can not “save” an unconsumed service.

I feel our society is doomed because we have moved away from this common sense approach. We have used fiat paper money to be used in place of savings. Instead of consuming fewer economic goods that we produce, we just introduce more paper money to finance our projects. Similarly, we seem to have convinced foriegn governments to go along with our scheme. Instead of demanding that we produce and deliver to them goods and services of the same economic value that they deliver to us, they have agreed to merely acquire our paper dollars.

And we have gone about our merry way as a society. This monetary inflation has taken the Dow Jones from 850 or so in 1980 to 14000 last year while the value of gold has performed dismally over the same time. Clearly, the last 20 or so years have been the domain of the permabull, while permabears such as myself have had little choice but to sit back and scratch our heads that an economy could seemingly prosper in the midst of every increasingly levels of debt and monetary inflation. But I believe we are now seeing the end of the era of the permabull.

Everything in permabull land is based on confidence: both at the consumer level and at the international level. Foreign governments wouldn’t take our inherently worthless bits of paper in exchange for their real goods and services if they did not have confidence of their value. I suppose it’s conceivable that they will continue to have confidence in our monetary system as the Federal Reserve pulls money out of thin air to aid failing banks, but it doesn’t seem likely.

So you see, it’s not the writings of Karl Marx that stir the souls of permabears, but instead those of Adam Smith. The permabulls may have been laughing at us for the last twenty years or so, but we were the ones laughing today., and I must confess that it felt really good.

Peter Bernstein Admits He Had No Answer to Current Crisis

For those of you who haven’t read it in the New York Times, it would seem that Peter Bernstein has added his voice to Ben Stein in saying that he’s not really sure what is to be done. Bernstein is a writer I respect, for he is one of the few people who talk about the economy today who has knowledge of the history that has come before it. I find that most economists or economic pundits seem to have no knowledge of history whatsoever, and thus have no means with which to test their theoretical knowledge (much of which came from Keynes) against actual historical events. Given that you can easily find many historical refutations of many aspects of macroeconomic theory, I can’t say it’s surprising that economics and history are treated as two separate disciplines with no actual overlap by most people.

Bernstein is an exception to all this. His books, such as Against the Gods are almost nothing but history. However, despite his historical frame of reference, Bernstein still marvels as the modern wonders of macroeconomic theory as though it were the culmination of all the experience gained from all prior events that he talks about in his books. Like virtually all people today, we have a bias towards are modern ways; surely they must be superior to the archaic way that people used to do things. This bias seems to have convinced Bernstein that the bailout plan that Congress is putting together is the correct thing to do. As far as he is concerned, it must happen, else we will revisit the times of the Great Depression when the streets of Manhattan were “filled with unshaven men in threadbare clothes, their coat collars turned up against the cold, their shoes stuffed with newspaper to plug holes in the soles.”

It seems clear to me that despite Bernstein’s historical knoweldge, he has not read any of the great works of the Economic Historian Murray Rothbard. Anyone reading America’s Great Depression would know that is was precisely these types of bailouts that President Herbert Hoover tried at the very outset. Dr. Rothbard clearly shows how the price support mechanisms that President Hoover put into place to maintain the prices of everything from wages to wheat all failed miserably and merely exacerbated the economic downturn and that the “banking holidays”, gold confiscation, and deficit spending of FDR also simply made things worse. After all was said and done in regards to The Great Depression, all that had been accomplished was to for the government to claim responsibility for the economy and to adopt previously unheard of authority to achieve a promised ends that it never could. Thus what we are seeing today is more of the same of what we have already seen before. It didn’t work then, and it won’t work now.

But Bernstein seems oblivious to all of this, which is tragic given his historical knowledge. But he does analyze where today’s situation could lead if it should succeed- to an even more pronounced level of risk in the economy. You see when you provide insurance for something, you often provide an incentive to do the very thing you are insuring against. It’s called “moral hazard” in the insurance industry. For example, if you take out a insurance policy safeguarding your house against fire, you now have a motive to burn your house down and claim the cash reward.

The same problem is at work in today’s markets. By way of this bailout, the government is adopting what Bernstein terms a policy of “Thou Shall Not Fail” regarding the banking industry. So, by the logic of moral hazard, the banking industry now hse incentive to take even bigger risks because the government will always be there to bail them out should they go wrong. Much like the “Greenspan Put”, today’s bailouts done for market stability will lead to an ever increasing amount of risk and instability in the future. Anyone can see that this process can only continue until, inevitably, the entire system fails. Bernstein himself declares the absolute necessity of the bailout, but sees the moral hazard implications. Thus, he ends his NY Times piece by saying “As we move into the future, and as the crisis finally passes into history, how will we deal with this earth-shaking blow to the most basic principle of our economic system? I do not know how to answer that question. But we need to ask it.”

You can ask all you want Bernstein, it won’t change a thing. Markets will take on increasing risk until they exceed the guardian’s ability to stabilize it. When that point it reached, the collapse takes down the whole system with it. This points to why the bailout is merely an exercise in folly. History tells us it will do nothing but prolong the crisis and, should it actually succeed, it will only manage to insure that the next crisis is even more pronounced.

Ben Stein’s Money Bet on the Wrong Things

For market Bears like me, the current market environment is absolute heaven. I’ve been making money off of my short positions, but I decided to close those today (which should make the government happy) because gold stocks are starting to look very attractive to me. Specifically I’m thinking of backing up the truck and buying Barrick Gold (Ticker Symbol ABX). Gold stocks have been down quite a bit in the last few weeks and considering how much money the government has decided to throw at the financial bailout this week I’m thinking gold miners are going to make out like bandits. You see, the government doesn’t actually have any money to bailout anything. As I’ve been telling my friends, America is broke. And I’m not sure that foreign lenders are going to want to line up to loan another Trillion or so to us given how indebted we are and how our financial system seems to be imploding. Inquiring minds suspect that the government may have to resort to just printing the money for the bailout, and that would be VERY good for gold and even better for gold miners.

GRRRR! Bear market profits are the best kind. But what can be even more satisfying is reading Ben Stein’s latest offering. For those of you who don’t follow him (and I recommend you don’t), Mr. Stein is known as a permabull for his perpetually sunny outlook on the American economy. So it is with special satisfaction that I read Mr. Stein as he tried to explain how exactly the US economy got into such a pickle, and I most confess a few moments of self-congratulatory laughter as he explains why exactly he was so wrong in saying a year ago that subprime mortgages were not capable of sinking the American economy. You see he reasoned that subprime mortgages were only $250 billion or so and could not sink a multi-trillion dollar economy. He is now admitting that he neglected to figure in the Credit Default Swaps that DID run into the trillions of dollars and how all of these unregulated debt instruments floating around that were pyramided on top of that debt are in fact causing a real problem. Oh well, Ben. I guess we all get them wrong from time to time.

Except it seems like all Ben would have had to have done to avoid having to scrap egg off of his face now would been to have visited some bear market sites and read what the bears were saying. Heck, even if he wanted to write us all off, he could have listened to Warren Buffett saying that credit derivatives were financial instruments of mass destruction. It’s not like nobody knew this was going to happen. I specifically remember reading Mr. Stein’s work a year ago in absolute astonishment that he did not seem to comprehend the ripple effect that these defaults would have.

Mr. Stein closes his financial advice column by asking what it is that we should all do. Which isn’t really any advice at all. Well, I’ve already told you what to do. Load up on gold miners. If you’re looking for more advice on how we got into this mess, how you can save money, and the best ways to invest for your future, why not buy a copy of my book.

I promise it doesn’t end with “What the heck is to be done?”

Waiting for the bailout shoe to drop

The markets started this week with quite a fall on Monday with the Dow down over 4% and gold up strongly. Tuesday and Wednesday have been a good bit more calm with stock prices falling slightly along with gold. It seems investors want to hold onto cash until things become more certain. Everyone seems certain that the government will bail out Wall Street from this situation, but there seems to be some disagreement about the details.

I’m sure that there are a legion of Wall Street lobbyists right now working furiously to try to get Washington to pay top dollar for all of the dead assets currently sitting on so many balance sheets. And if this were anything but right before an election, they’d probably get their way. But Senators McCain and Obama are no doubt wondering how this bailout is going to look to the voters if Wall Street makes out like bandits on taxpayer money. So now Wall Street is uncertain as to what the terms of the plan are going to be.

The American voter, much like the American consumer, is expected to have a very short attention span. They aren’t suppose to be able to really understand what’s going on for themselves, you see, so this bailout plan has to be turned by the political pundits to become something so easy that your average voter could understand it. “Wall Street is bailed out by your money after a long period of making money off of you,” is just the kind of thing to work up voter ire. It is, as Bill Bonner suggests, just one grand spectacle.

The one question that I’m sure will never be asked by either of the candidates or anyone, is “Where is this $700 Billion supposed to come from?” Much like the war in Iraq, it’s just expected that someone will be nice enough to front us the money for us to continue down the path of spending far more than we’re making. That someone has increasingly been foreign investors, and I’m not sure how well they’re going to react to our asking for another Trillion or so. They probably think that it’s a shame that they don’t get a voice in this election, but if things keep going like this it’s a good guess that their time will come.

After all, a politician may get elected promising to keep us safe from terrorism by “fighting them over there, so we don’t have to fight them over here”, but when the American people have to actually start paying the real bill for these military misadventures, we may suddenly find that we’ve lost our taste for blood. Let’s not forget that we asked a lot of foreign investors to buy these same toxic credit derivatives in the first place, and no government has been nice enough to step forward and bail them out.

SEC Decision to Hinder Short Sellers

The first stock market to develop after the fall of the Roman Empire found it’s home in The Netherlands. The Dutch East India Company’s shares of ownership became traded amongst Dutch citizens in coffee houses and soon an exchange was born. To buy a share in the Dutch East India Company was to hope that the company’s health and revenues would be higher in the future and that you would therefore own a piece of a more valuable company. But not long after this first stock market came about, did other kinds of stock transactions come about. Among them was the “short sale”.

A short sale is where you borrow shares of stock from someone else and enter into a contract to replace those borrowed shares at some future date. You would then sell the borrowed shares on the open market and look for an opportunity to buy them back at some point in the future. If you could buy them at a lower price, then you would have realized a profit on the difference between the price you originally sold it at and the price you were later able to buy it at. It’s a twist on the old axiom of buy low and sell high; you sell high and then buy low.

Since the practice first came about, short selling has not been popular. Buying stock in a company is basically betting on the company’s future success while shorting stock in a company is betting on the company’s future failure. It’s akin to playing craps and putting your money on the “Don’t Pass” line; you just don’t make friends betting on other people’s failure. And unpopular figures often find themselves the scape goats during a crisis, which is what we’re seeing now.

For those of you who don’t follow the financial news everyday, the SEC has been taking an increasingly aggressive stance against short sellers. Back in July of this year, the SEC banned a practice called “naked” short selling against a handful of financial firms. A naked short sale is when you sell the stock without having to borrow it first. The strange thing is that this practice is already against the law. So in essence the SEC came out in July and outlawed an already outlawed practice, but only against a select handful of financial firms such as Freddie Mac and Fannie Mae. Clearly this was an attempt to bolster the price of the stock of financial firms who were perceived as vulnerable.

Fast forward to this month, and the collapse and bailout of Fannie Mae and Freddie Mac. The SEC once again took the bizarre step of banning the already illegal practice of naked short sales, but this time around they extended it to the entire market. Then came the bankruptcy of Lehman Brothers and the bailout of AIG last week. As part of the bailout proposed by President Bush, there are two provisions which specifically target short sales:

1. All investment managers must publicly disclose whatever short positions they have.

2. Short selling has been out-and-out banned for financial firms.

Clearly the SEC are taking a more aggressive stance against the short sellers in an effort “to maintain stability.” It’s also clear that the SEC is acting on concert with both the Secretary of Treasury Hank Paulson as well as Chairman of the Federal Reserve Ben Bernanke to try to prop up the market.

Blaming short sellers for market collapses or having the government ban the practice altogether is not an old tactic. Historically it would seem every time a market collapses, the government comes down against short sellers. The US Government outlaws short sellers after that market collapse of 1929, but found that the stock market only continued it’s decline. Similarly, the moves against short sellers this year has done nothing to stem the tide of stock market loses for people who were shareholders in Fannie Mae, Freddie Mac, and Lehman Brothers.

The reason that banning short sellers is ineffective is that they are not really the cause of the market decline. Short sellers did not force the bankruptcies that have occurred this year. They did not entice prospective home owners with adjustable rate mortgagees they couldn’t afford, nor did they convince Wall Street Firms to buy securities associated with these repackaged mortgage loans. They did place a wager that the enterprise wouldn’t turn out well, and that has allowed them (including myself) to profit off of the demise of others as markets have collapsed this year. But so what?

It’s the height of hypocrisy for the government to try to protect Wall Street firms, who has always been motivated by profit before anything else, by banning the very tools that many of them are still using to this day to earn a profit. When Goldman Sachs disclosed last year that it had a strong quarter because it had placed short sales against the very credit instruments it was selling to its customers, no one batted an eye. But now that Goldman finds itself the target of the short sellers, it gets bailed out by the government. And it’s particularly ironic that the this government is run by Republicans who have long been advocates of the “free market”.

It would seem that President Bush’s free market policies are similar to his policies of against nation building; a convenient sound bite to give out when times are good, but quickly forgotten when it might actually matter.